"Ever-deeper, ever-further" has been the mantra of major natural
resource producers over the past decade, as emerging Asia has
replaced the US as the world's single biggest consumer and driven
demand to new heights.
This unprecedented expansion hasn't always driven up costs. In
fact, major producers of everything from copper to platinum are
uncovering some of the richest reserves yet seen with their massive
investment. That's helped keep a lid on companies' overall
production costs, which in turn has aided further investment. It
has, however, elevated resource nationalism risk to heights not
seen since the 1970s, when countries such as Chile expropriated
assets from investors domestic and foreign.
Among the more alarming recent developments concern South
Africa, long one of the world's biggest producers of scores of key
resources. In July, an increasingly violent clash between rival
unions hampered production at a mine owned by Lonmin Plc, the
world's third-largest platinum producer.
The battle between the Association of Mineworkers and
Construction Union (AMCU) - a nascent organization centered on less
skilled workers - and the incumbent National Union of Mineworkers
((
NUM
)) concerned a demand for higher wages for rock drillers. NUM
refused to strike in support and the result has been chaos at the
mine. In August, riot police killed 30 striking workers at the
mine, escalating tensions between workers and management.
Unfortunately, the battle is just the latest in a series of
developments that has undermined investor confidence in South
Africa.
Mining companies
today face periodic shortages of electricity, and wage costs have
risen far faster than inflation. Most worrisome, politicians are
now debating outright nationalization of much of the mining
industry, as the ruling African National Congress struggles to
maintain its monopoly of political power.
Given the country's vast mineral wealth, investors are unlikely
to abandon it entirely, unless forced out. But the Lonmin incident
is a sober reminder of the political risks facing mining companies
as they look for new sources of supply to meet rising demand.
South Africa is hardly the only country facing these risks.
Violence among workers in New Guinea, for example, has interrupted
production at major mines there. Other countries in Asia and Africa
are also studying ways to get more from foreign mining firms. And
while Australia has turned back a more draconian version of its
proposed mining tax, even this investor-friendly country has been
debating raising levies.
However, there are positives to resource nationalism. Most
important, the growing risk it poses to supply helps build an
effective floor under prices of many key minerals, just as Middle
East turmoil has for global oil prices for decades.
With Chinese industrial production noticeably slowed from last
year, this trend is likely to prove very important for global
prices and producer profits over the next six to 12 months, or at
least until the Chinese economy accelerates again. However,
companies will only really benefit if their reserves and output can
be maintained from outside troubled countries. Otherwise, output
will drop and they'll be victimized by lower prices and falling
volumes.
One way investors can protect themselves is to stick to large,
geographically diversified resource producers-or failing that, to
focus on companies that get the majority of output from more
politically stable countries where the odds of radical resource
nationalism taking hold are lower.
North America is obviously the top choice, particularly Canada
where the government has even been willing to allow foreign
takeovers of resource producers. The
Australian economy
also has a long history of stability, the recent proposed mining
tax notwithstanding. And despite the rise of bellicose left-wing
governments in Argentina, Bolivia, Ecuador and Venezuela, Latin
America remains largely open for mining companies' business,
particularly Chile and Brazil.
Accordingly, I like to hold a mix of mining companies. In
general, companies diversified over several countries are safer,
because they're less exposed to negative shifts in regulation
and/or flare-ups of resource nationalism. More focused companies
are often smaller and therefore more leveraged to upside in the
market for what they produce.
Resource nationalism is also a powerful driver for mining
industry mergers, because larger companies are financially better
equipped to weather interruptions in output caused by political
strife and sudden regulatory shifts.
The biggest merger deal currently in progress involves
Glencore International
(GLNCF.PK), which has an outstanding bid for major metals producer
Xstrata Plc (XSRAY.PK), of which it already owns a sizable
chunk.
Given the expense and risk of going "ever-deeper, ever-further,"
the odds of more big deals being announced in coming months
continues to rise, as borrowing costs remain historically low and
falling resource prices pressure earnings.
If you own a mining company that is affected by resource
nationalism, your first course of action is to determine what's
actually at risk. In most cases, the market is likely to overreact
to the danger and successful mining companies are skilled at
finding compromise.
Freeport-McMoran Copper & Gold
(
FCX
), for example, is considering offering a portion of its PT
Freeport Indonesia unit to the Papua administration of between 5
percent and 9.4 percent. The company's Grasberg copper mine is
among the most prolific and lowest-cost in the world - these
operations have been closely scrutinized by government and at times
interrupted by labor strife. Having local government as a
de facto
partner could go a long way toward settling that strife.
Other companies have been able to overcome the ill effects of
resource nationalism by virtue of diversified operations. Canada's
First Quantum (FQVLF.PK), for example, saw its assets in the
Democratic Republic of the Congo essentially expropriated but was
eventually compensated and has since moved its investment to more
hospitable terrain.
It's a sure bet that governments in the future will continue to
use their power to change the terms of contracts for some
companies. When the investment in that country represents most or
all of their operations, affected companies will be at risk of
folding. However, if you stick to diversified miners, any emotional
market reaction to a flare-up of resource nationalism will likely
represent a buying opportunity.
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
See also
Is China The Biggest Malinvestment Case Of All
Time?
on seekingalpha.com